NY futures continued to move higher this week, as May gained 104 points to close at 77.82 cents.

After posting a 34-month high of 79.46 on Monday, the May contract has entered another corrective phase, but nevertheless managed to close near the 78 cents level over the following three sessions.

The primary uptrend, which has now been in force for over a year, is still alive and well and shows no signs of exhaustion. It is hard to believe that the market has advanced by over 23 cents since the spot month posted a low of 54.53 cents on February 29 last year.

Another week has gone by and not much has changed in what is driving the market. The latest CFTC spec/hedge report showed speculators still at 11.5 million bales net long, while the trade was 18.4 million bales net short. Index funds account for the balance with a 6.9 million bales net long position. These are more or less the same positions we had in late November!

The same goes for unfixed on-call sales, which at 11.54 million bales are still a great concern and are in fact more than two million bales larger than they were at the end of November. Even more disconcerting is that 8.01 million bales are open on May and July, for which time will run out in a little over three months from now.

Some traders start to worry when the market pulls back a cent or two after an advance and wonder whether this might be the end of the bull market. But when seen in the context of the above positions it all makes sense. When the market advances it often lacks follow-through buying and is then forced to pull back. That’s because speculators are already quite long and won’t chase prices higher, while trade shorts are not willing to pay up and are instead waiting for dips to buy and fix.

While trade shorts can still afford to play this waiting game for a while longer, the trap they are in won’t simply disappear. Ultimately mills will have to fix their May and July on-calls and merchants will have to buy back the shorts they hold against these fixations. When that happens, speculators are needed to provide sell-side liquidity, and therein lies the problem.

As long as the uptrend stays in force, speculators won’t simply quit their long position. In our opinion they will only do so if a) the uptrend is broken or b) the market spikes sharply higher and speculators then sell into the blow-off phase. At the moment all these specs need to do is patiently wait for the trade shorts to run out of time!

The pace of US export sales continues to feed into this bullish narrative, as week after week we get surprised with blockbuster sales numbers. Last week the US sold another 481,100 running bales of Upland and Pima cotton for both marketing years combined. Once again participation was broad-based with 20 markets buying and 26 destinations receiving shipments of 544,100 running bales, a marketing-year high and the highest amount in nearly 11 years.

Total commitments for the current marketing year now amount to 12.1 million statistical bales, of which 7.3 million have already been exported. And there are still over 21 weeks to go in the season!

Today’s WASDE report was uneventful as the USDA made only minor adjustments to its numbers. The focal points were the 271,000-bale increase in the US crop to 17.23 million bales and a 0.5 million bales increase in exports to 13.2 million bales.

Other than that there were only some small changes made. However, we feel that the USDA needs to go over its books since ending stocks in China and India are overstated. Based on private sources we believe that Chinese stocks are about 6-7 million bales less than the USDA tells us and in the case of India it could amount to around 2.0 million bales.

Chinese Reserve auctions were off to a good start this week with more than 30,000 tons finding buyers in each of the first four days of the new campaign. That’s no surprise really since the statistics tell us that Chinese mills need around 2 million tons of this Reserve cotton to meet their needs. Since freely available stocks were tight in China at the beginning of the season, the 13.75 million bales seasonal production gap has to be filled with 4.5 million in imports and around 9.25 million bales in Reserve cotton.

So where do we go from here? From a technical point of view the 53-week primary uptrend is still in force, which is keeping speculators on board. The trade on the other hand seems to be trapped with its large net short position, about half of which is against unfixed on-call sales. Mills are growing increasingly frustrated with this ‘two steps forward – on step back’ market since they don’t seem to catch a break that would allow them to get out of their predicament.

So far no progress has been made on these fixations, since there are still 8 million bales that need to be fixed between May and July. As time is running shorter every passing week, this sets up as a potentially explosive situation. We see strong underlying support in the 76-77 ‘fixation zone’ and the potential for some spike rallies over the coming weeks.

Once May and July are off the board, the market will probably take on a different complexion. New crop plantings will increase significantly and mills won’t make the same mistake again with the way they contract cotton. Given the empty pipeline at the end of the season December will probably still see decent support, while bearish forces are possibly coming into play beyond that.

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